Milestones achieved, but transition elusive
The transition to SOFR from LIBOR has seen some key milestones passed over the last few years. CCP discounting and PAI to SOFR: Check. ISDA fallbacks: Check. Term SOFR rates: Sort of check. However, the hoped-for burst of flow and liquidity in the SOFR derivatives market remains elusive, and the OTC markets have largely continued business as usual, trading largely LIBOR swaps and options even as SOFR futures and SOFR basis continue to grow.
With the deficits of SOFR well known (average daily O/N rate on repo, not credit sensitive), market participants have seen more airplay for credit sensitive term rates. Lately, BSBY has garnered the most interest albeit alongside continued interest in Ameribor.
BSBY inquiry rises
Looking at BSBY, one market participant acknowledged that he gets asked “a lot” about it. Another added, “I can certainly see the demand for BSBY” and with the deadline for the termination for new usage of LIBOR looming, he judged that users of LIBOR are “getting the message from regulators and the message has been received" and BSBY is LIBOR-like as it has "credit sensitivity and is a term rate."
Meanwhile, a SOFR term rate is something that the Street “will fight for” as the 1m, 3m and 6m term rates resemble LIBOR. CME recently introduced term SOFR rates, and is seeking approval from ARRC. (please see link for more).
“Most corporates are used to looking at their liabilities in 1m, 2m and 3m and LIBOR plus terms,” pointed out a source, and “rolling every 3 months.” Looking at BSBY, one market participant thought that the index “should work,” and sources note that in swaps, BoA and JP Morgan executed the first BSBY swap, a 1y trade on April 30th, while at least one broker SEF says it is ready to quote BSBY, sources say.
Meanwhile Ameribor is a reference rate that is “supported by regional banks,” noted a source. Zions Bancorporation last month announced its “intent” to use Ameribor in loan agreements in place of LIBOR and a source noted that a regional bank has issued in Ameribor. Indeed, regional bank Signature Bank issued a $375m fixed-to-floating subordinated10y based on Ameribor last year in October. However, market participants wondered of the reception for the index beyond US regionals, adding that demand for a rate called Ameribor might be limited beyond the US.
SOFR options trading picks up
On the non-linear side, recent weeks have seen an uptick in SOFR options trading activity in the interbank market. 18m2y, 2y2y, 3y10y, 1y5y and 2y5y swaptions along with 3x5 CFS are some of the recent markets that have been quoted and traded, either outright or as a spread to LIBOR equivalent. Some SOFR vol structures have traded above LIBOR vol, especially for the shorter dated trades, sources note.
“There's definitely been a pickup in SOFR options,” agreed one dealer. However, he found that trading has been “nothing really interesting yet” especially in regard to “takeaways for what the SOFR surface will look like vs LIBOR.”
So far trades have gone through based on “supply and demand and where people have risk,” explained one source.
SOFR trigger lacking
“There’s SOFR/LIBOR and SOFR/FF but SOFR/UST has not been happening yet,” remarked one source. Some corporates are “looking at SOFR, but it has mostly been Fed Funds,” he noted, and the “bulk of the activity” remains LIBOR.
The issue is not that dealers aren’t ready to trade SOFR - most are – but, “you really need a SOFR-Treasury spread like there is OIS to USTs,” the dealer added.
Another agreed that the market has yet to trade SOFR as a duration tool, and has only been traded as a spread to OIS, LIBOR mainly.
“If you told me a year ago this is where we would be with eight months ago, I would have thought the market would have been more developed,” another trader opined..
Looking at the development of SOFR activity thus far, one dealer suggested that perhaps, “one day we will all just wake up and just start trading SOFR,” jokingly adding “and Goldman will tell us all how to do it.”
Multiple choice questions
“There are a lot of problems with SOFR. Maybe what should have happened - or could happen - is one rate for cleared and another, credit-sensitive uncleared swaps,” considered one dealer.
Another reckoned that the market is prepared for multiple indexes and said this would not be an unwelcome development. Ultimately market-makers are “prepared to make whatever markets” are desired by end-users.
“There is room for multiple indexes,” another trader concluded, and the market just needs to see “what picks up in popularity.”
Does anyone need a rate that doesn’t move?
If another index besides SOFR gains most traction, the source considered that this would be “more fun than SOFR” as it is “difficult” to have a benchmark that “does not move”.